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Correction to This Article
Earlier versions of this story, including in the print edition of The Washington Post, misstated the quarter in 2008 when AIG posted the largest loss in U.S. history. The $62 billion loss came in the fourth quarter.
Officials Knew of AIG Bonuses Months Before Firestorm

By David Cho and Brady Dennis
Washington Post Staff Writers
Wednesday, May 13, 2009

As American International Group chief executive Edward M. Liddy returns to Washington to face Congress today, new details are emerging about how long federal officials were aware of the company's recent bonus payments to its executives and of how inflammatory the payments could be.

Documents show that senior officials at the Federal Reserve Bank of New York received details about the bonuses more than five months before the firestorm erupted and were deeply engaged with AIG as well as outside lawyers, auditors and public relations firms about the potential controversy. But the New York Fed did not raise the alarm with the Obama administration until the end of February.

Timothy F. Geithner, who became Treasury secretary early this year, was the head of the New York Fed when it became aware of the bonus details. But his name is not among those of senior New York Fed officials mentioned in the summaries of phone calls, correspondence and other documents obtained by The Washington Post.

Those documents also illuminate who in the government, beyond the New York Fed, knew what about the bonuses at AIG's most troubled unit, and when.

Key members of Congress began investigating the payments as long ago as October and, beginning in January, repeatedly warned the Treasury about the matter.

In early February, Fed officials in New York sent details about the bonus program to their counterparts at the Federal Reserve in Washington, to prepare Chairman Ben S. Bernanke in case he was asked about the payments at a congressional hearing.

By the time the Obama administration was fully engaged in early March, the New York Fed had determined that AIG was legally bound to pay the bonuses to its Financial Products division, the documents show. Top New York Fed officials also huddled with AIG about developing a strategy to mollify angry lawmakers -- but that did little to quell the firestorm that ensued.

The furor over the bonus payments at AIG -- the crippled insurance giant that is benefiting from a government bailout of more than $180 billion -- disappeared from public view as quickly as it erupted in mid-March.

At the height of the controversy, the House passed a resolution that would tax the bonuses at 90 percent and the Senate introduced an even harsher bill, which it abandoned as AIG employees began promising to return the money.

But even after the storm, the fallout remains. As the financial crisis demands their attention, senior Treasury officials have met several times a week since March to review, one by one, the bonuses of even lower-ranking AIG executives, sources familiar with the discussions said. Geithner attended some of the initial meetings.

Ongoing Legal, Tax Issues

AIG is still grappling with the legal and tax issues surrounding the bonuses while trying to stay afloat. And while employees of AIG's Financial Products division have said they intend to repay nearly a third of their $165 million in bonuses in response to the public outcry, it is unclear when or how much will be returned.

After the initial $85 billion federal bailout of AIG in September, the New York Fed, which is accustomed to dealing with banks, struggled to understand a complex global insurance company.

"They really didn't know us at all," said one AIG executive, who was not authorized to speak publicly. "We had a real education process with them. They were asking us questions on a gazillion different issues."

By Sept. 29, the bonus matter first appeared on the radar of the New York Fed, which was designated as the primary contact for AIG, documents show. Senior officials from the New York Fed met with AIG officials to discuss the compensation plans in place at Financial Products, whose risky derivative contracts had brought the insurance giant to the brink of collapse.

AIG e-mailed officials at the New York Fed copies of the company's compensation plans, which detailed bonuses and retention payments, including those at Financial Products, documents show. The issue arose in scores of meetings and conference calls over the ensuing months. AIG also disclosed its retention programs in public filings.

For the New York Fed, the primary contacts were Jim Hennessy, counsel and vice president, and Sarah Dahlgren, a senior vice president and head of its bank supervision group. Leading the effort at AIG was Anastasia Kelly, the company's executive vice president and general counsel. Ernst & Young participated as an outside auditor, along with New York law firms including Sullivan & Cromwell.

Throughout the fall, the correspondence between New York Fed officials and AIG proceeded but without the urgency of later discussions. The company was still in danger of imploding -- along with the rest of the financial system -- so examining bonus payments to several hundred employees was not a top priority among the Fed officials.

Geithner has said in interviews that he was getting regular updates as president of the New York Fed and was vaguely aware of the bonus issue but that he was not apprised of the specifics.

A Political Storm Erupts

The spark that would grow into a political firestorm began in October when lawmakers began to request documents about the compensation at Financial Products.

Rep. Elijah E. Cummings (D-Md.) in particular latched on to the issue.

By January, AIG was feeling heat from lawyers at the House Financial Services Committee, and from the offices of Rep. Paul E. Kanjorski (D-Pa.) and Rep. Joseph Crowley (D-N.Y.), who one staff member noted in an e-mail to AIG was "very upset about these payments." Kanjorski has said that around this time his staff began calling the Treasury about the issue and sending letters, but communication was hindered by the transition between administrations.

The frequency and urgency of the correspondence between AIG and the New York Fed ratcheted up. Fed officials openly debated with AIG officials over how to handle the coming storm and examined whether there was a legal way to escape making the bonus payments or at least delay them.

"Did we think people were not going to like this? Sure," an AIG executive said. "But did we think it was going to be the Armageddon of compensation? No, we didn't."

The New York Fed officials continued to keep their bosses in Washington updated. On Feb. 9, Hennessey e-mailed the Fed in Washington, informing officials that the retention programs were devised in 2007 -- "another fact relevant to any question Bernanke gets on FP retention."

Bernanke has said in congressional testimony that he was not made aware of the issue until around March 10. After his staff informed him about it, he tried to stop the payments but was counseled by Fed attorneys that there may be no legal way to do so.

In Plain Language

As the outcry on Capitol Hill grew louder, Hennessy of the New York Fed sent an e-mail to Stephen Albrecht, a Treasury attorney, on Feb. 28, documents show. The correspondence was intended to set off alarm bells: More than $160 million in bonuses would be paid in March to AIG's Financial Products unit, the e-mail stated plainly.

"This was triage, Treasury triage," said the AIG executive, noting the department had been largely absent from the discussions to that point. "When they finally realized it was a heart attack and not the measles, it was too late."

By that time, senior officials at the New York Fed and AIG were resigned that nothing could be done to stop the bonuses. On March 2, Hennessy received an opinion from an outside legal counsel concluding that AIG could be sued if it failed to make the payments as originally crafted.

That same day, the company posted a $62 billion loss for the fourth quarter of 2008, the largest corporate loss in U.S. history. The government announced its fourth bailout for the firm, raising the total rescue package to more than $180 billion.

After growing convinced they could not restructure the payments, Hennessy, Dahlgren and top AIG officials focused on devising a strategy for presenting the matter to Capitol Hill.

Senior Treasury officials have said they had been aware of the bonuses, but not their specifics, since early February. But the e-mails from Hennessy alerted the department that big trouble was on its way.

Geithner said in interviews that he had been preoccupied with the financial crisis and was taken aback when he was told about the extent of the bonuses. But he said he took responsibility for not knowing about the details of the bonuses earlier.

Geithner called Liddy on March 11, demanding that the company restructure the bonuses. Liddy began drafting a letter that bowed to some of Geithner's concerns. Because the letter was to be released publicly, Treasury officials reviewed drafts and suggested changes.

The letter was released March 14. But it was too late. The bonuses to executives at Financial Products were already heading out the door.

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